2020 has been a difficult year for India’s small and medium-sized enterprises (SMEs). Due to a lack of cash flow, many start-ups and small businesses have been unable to purchase critical supplies such as raw materials and spare parts. The overall drop in demand has made it impossible for SMEs to continue operating as usual. To top it all off, there has been a significant increase in the number of bankruptcies since the lockdown, which has only added to the market’s sense of insecurity.
An increasing number of Indian businesses are putting their faith in a relatively new credit financing method that promises to optimise working capital flow while allowing them to focus on growth. As a result, Supply Chain Finance, abbreviated SCF, has enormous potential for closing the large gap between invoice generation and settlement. It can assist small businesses in the post-COVID market in addressing cash flow uncertainty and strengthening supplier relationships.
Benefits of Supply Chain Finance for SMEs:
1) Improves liquidity:
Extended credit lines of up to 120 days have been necessitated by the severe cash crunch being experienced by businesses on account of COVID-19. If the buyer faces a working capital shortfall, SCF can relieve the pressure on their accounts payable, helping them to focus on top-line growth.
2) Enhancing credit financing options for stressed SMEs:
SMEs in India have traditionally been viewed negatively by lenders due to their poor or non-existent credit history. Banks are understandably hesitant to take on additional risk, even as the volume of Non-Performing Assets (NPA) on their books remains high. SCF enables large corporations to use their relatively higher credit ratings to provide credit to SMEs. Smaller businesses can now obtain financing that they would not have been able to obtain otherwise.
3) No collateral required:
With SCF, SMEs are no longer restricted in their ability to secure credit financing due to a lack of collateral. The pending bill serves as collateral for the bank’s release of funds. Until recently, small business owners had to offer their personal assets as collateral to meet the lender’s requirements. This improves small businesses’ ability to overcome one of the most significant obstacles to running normal operations, particularly in the post-COVID scenario.
4) Lower cost of borrowing:
In India, the average interest rate on working capital loans ranges from 12% to 16%. While such loans are significantly less expensive than traditional moneylender financing, high EMIs can strain SMEs, especially when business is slow. In comparison, supply chain financing has interest rates ranging from 2-4%, making it the clear winner when it comes to gaining quick access to working capital. When demand-supply cycles are uncertain, it is a much more sustainable form of business finance.
5) Provides strategic flexibility:
SME buyers can use SCF to source low-cost products from suppliers and increase their profit margins. Cash discounts offered by suppliers for prompt payment can also be substantial. Buyers can foster an ecosystem of preferred suppliers by providing financing assistance, thereby increasing their competitiveness in a volatile pandemic-affected market.
Cash flow disruption is perhaps the most significant challenge that SMEs face today, making timely credit access even more critical. SCF enables businesses to shorten the sales cycle and pursue growth opportunities more aggressively. For lenders, it can play a critical role in restoring market confidence, resulting in increased credit volumes – and growth – across the board.
Authored by Sahaj Chopra, Co- Founder and Director at Fat Tiger